Court Applies “Reality Check” to Valuation of Minority Interest in LLC

Court Applies “Reality Check” to Valuation of Minority Interest in LLC

      In a recent decision from Ohio, the court applied a “reality check” to the evaluation of a minority interest in LLC, the court rejecting the suggestion that a 25% interest therein held a negative value. Kapp v. Kapp, 2019 Ohio 4097, 2019 WL 4894057 (Ohio Ct. App 2nd Dist. Oct. 4, 2019). 

      Jessica and Tyler Kapp had previously been married; this decision arose out of the divorce decree entered by the trial court. For purposes of this review, she alleged that the value attributed to her interests in two self storage businesses was in error. Tyler and Jessica were each 25% members of Home Road Self-Storage and in Key and Lock of Enon. The balance of the interests in the companies were held by Tyler’s sister and her husband. The trial court, after determining that the interest in each of the LLCs had, as to Jessica, negative discounted present value, had awarded those interests to Tyler without any offsetting compensation to Jessica.

      Tyler’s appraiser began by doing an appraisal of each company, dividing that by four to reach the pro forma value of a 25% interest therein. He then applied a 35% discount to each interest. Then, he deducted from that value 25% of the mortgage indebtedness, an action which drove each of the values negative. Jessica objected to this approach by noting that, while her interest in each company had been discounted, no discount had been applied to the mortgage debt.

In contrast to the trial court’s approach, Jessica argues that it first should have determined the net market value of her interest by subtracting all debt from Horner’s appraised market value of the properties. She asserts that the result would then have been divided by four to determine the market value of her interest, which then should have been discounted by 35%. According to Jessica, if this methodology had been followed, the discounted market value of her interest in the two companies would be nearly $80,000.

This the court did not accept, writing:

It is not clear to us, however, why the debt should be discounted. Appraiser Horner explained why it was necessary to discount the market value of Jessica’s 25 percent interest in Home Road and Key and Lock. Most significantly, the value of her minority interest in the two companies is impaired by a lack of marketability or control. To determine what a buyer would pay for her share of the companies, Horner had to consider these impairments, which reduce the market value of what Jessica owns. The same is not true for the mortgage debt. Marketability or control issues impact the value of Jessica’s interest in the companies, but such issues have no impact on the companies’ debt. No lender would reduce the existing mortgage debt by 35 percent in recognition of the discount applied to Jessica’s ownership interest in the companies. As a practical matter, then, a prospective purchaser would be buying Jessica’s discounted ownership interest, which remains encumbered by the full, undiscounted pro rata share of the companies’ debt. There may be some explanation for discounting the debt in this case, but it is not found in the record before us. Therefore, we cannot say the trial court erred in failing to adopt Jessica’s valuation approach. 2019 WL 4894057,*4 (footnotes omitted).

      However, notwithstanding that rebuttal of her argument, all was not lost for Jessica. Rather, the court wrote: 

Despite the foregoing conclusion, we agree with Jessica that the trial court acted unreasonably in assigning no positive actual value to her 25 percent interest in the two companies. The record reflects that Home Road and Key and Lock are successful and profitable businesses. The undiscounted net market value of the two businesses, after subtracting their debt, is roughly half a million dollars. Certified public accountant Mike Fissel testified that Home Road was projected to have free cash flow of $20,518.86 over the upcoming year after servicing its debt and making one-time capital expenditures of $48,000 for needed repairs. The Key and Lock property was projected to have free cash flow of $3,379 after debt service. But an anticipated capital expenditure for driveway resealing was expected to reduce free cash flow to negative $1,621 for the upcoming year. In any event, the two businesses together easily were cash-flow positive after all debt servicing and capital expenditures. In addition, based on a current accelerated debt-repayment schedule, the Home Road property, which itself appraised for $920,000, is expected to be mortgage free by December 2026. Paying off the mortgage will allow the company to retain an additional $6,841.43 per month based on the current payment schedule. In short, the record establishes that relatively soon the two companies, which currently are paying for themselves, together will have equity in excess of one million dollars and will be generating substantial free cash flow. We find it unreasonable to conclude that Jessica’s 25 percent ownership interest in this enterprise is worthless and, in fact, is worth less than zero. The apparent value of Jessica’s interest is reflected in the fact that both she and Tyler desire ownership of it. Jessica testified at trial that if she were not awarded at least “book value” for her interest in the two companies, then she would prefer to keep her interest. At trial, the companies’ accountant, CPA Fissel, determined that the book value of Home Road was $97,533.60, and the book value of Key and Lock was $81,446.66. The combined book value of these businesses was $178,980.26. Jessica’s attorney calculated that 25 percent of the combined book value was $44,744.92. Jessica testified that she was agreeable to transferring her interest in the companies to Tyler for at least that amount. Otherwise, she wanted to retain her interest in Home Road and Key and Lock. Id. (citations to record and footnote deleted).

      From there, turning back to the company’s operating agreement, it was silent as to divorce and expressly excluded its application with respect to “transfer by sale, gift or bequest between or to current Members.” Still, the court made reference to the “fair market value” methodology set forth therein, one which valued Jessica’s interest $44,744.92. The court as well noted that as Tyler was already a 25% member of the company and, apparently, one of its only two managers, her interest was to him more valuable than it would be to a “hypothetical prospective purchaser,” the court observing “Because the ‘purchaser’ in the present case is a person who will own fifty percent of the companies and who shares control with only one other person, Jessica’s interest reasonably should have more value to him than to a random person.”

      From that assessment, the court turned to the crux of its decision, namely: 

Based on the foregoing reasoning, we hold that the trial court abused its discretion in finding Jessica’s interest in Home Road and Key and Lock to have a negative market value and in awarding that interest to Tyler without any compensation to her. Such a disposition was not reasonable based on the record before us. Although a trial court in a divorce proceeding should endeavor to disentangle the parties financially when possible, we believe the most appropriate resolution in the present case is for the trial court to give Tyler a choice. He can give Jessica $44,744.92 for her interest in the two companies and have that interest transferred to him. Or he can decline to do so, and she can keep her interest. Although it may be preferable to separate the parties’ business affairs, Jessica should not be compelled to give her interest in the companies to Tyler without any compensation, which is what the trial court ordered. If Tyler truly believes Jessica’s interest has no current market value, as he argues on appeal, then he can allow her to keep that interest, which she testified has financial value to her. Because Tyler and his sister enjoy decision-making control, Jessica essentially would remain a silent partner. The first assignment of error is sustained. Id., *6.

Respectfully, I Dissent: Dean Fershee and Elimination of Fiduciary Duties

Respectfully, I Dissent: Dean Fershee and Elimination of Fiduciary Duties

      Dean Fershee  recently circulated of a short paper titled An Overt Disclosure Requirement for Eliminating the Duty of Loyalty; HERE IS A LINK to the posting he made on the Business Law Prof Blog with respect to this short paper. Therein, at the risk of oversimplifying his argument, he suggests that the various LLC and other unincorporated entity statutes should be amended to provide, inter alia, that a post-formation amendment of the controlling agreement, he being focused in this context on LLC operating agreements, that would either reduce (even to the point of elimination) or expand the duty of loyalty would be permissible if and only if expressly provided for in the operating agreement or, otherwise, with the unanimous consent of the participants. He wrote that “it would be appropriate to me for Delaware to adopt a requirement that, to change or eliminate a fiduciary duty, there must be agreement of all parties or an expressed and clear statement as to what it requires to change that.” He would not allow such a modification to proceed under language providing only “This operating agreement can be modified or changed via majority vote.”

      As outlined below, I must respectfully dissent from this view. Generically, absent bespoke private ordering to the contrary, where either the controlling state law (examples being Kentucky and New York) or the operating agreement itself permits modification by less than a unanimous vote of the participants in the venture, they have placed themselves at the mercy of the agreement as amended. With precise drafting, the operating agreement may protect a minority participant protection from what might, ex post, be considered an abusive or oppressive amendment, that protection is, as it should be, the product of negotiated private ordering. Recall that the test is for whether the participants to an agreement understood the agreement they were entering into (i.e., this agreement may be amended by less than all of the participants in the venture.) and not all of the implications of the agreement into which they have entered (i.e., the duty of loyalty owed under this agreement is subject to subsequent modification, waiver or elimination.). 

      In short, I do not believe there is justification for protecting people from the consequences of the contracts into which they enter. 

      Second, I do not see the application of a rule such as that espoused by Dean Fershee could practically be applied as there would be myriad questions as to its scope. Admittedly, it would control with respect to a proposed amendment to the operating agreement of “notwithstanding [cite duty of loyalty provision of controlling LLC Act], and to its exclusion, no member/manager in the Company shall be bound by or subject to any duty of loyalty.” Okay, fine, but let us now assume an LLC organized for real estate development purposes that is the current title owner of 234 Chestnut Street. May whatever threshold of the members is defined in the operating agreement as being able to amend it [the “Majority Members”] change the purpose clause of the LLC to provide “the sole and exclusive purpose of the Company is to own, develop, lease and ultimately sell the improved real property located at 234 Chestnut Street. The Company will engage in no other activities.”? With this amendment to the operating agreement the scope of the duty of loyalty that might otherwise apply has been constrained, thereby allowing the members to be engaged in other real estate project without violation of the opportunity doctrine or an obligation to not be involved in activities that are competitive with the LLC. May the Majority Members amend the operating agreement to provide, inter alia, that they are permitted to engage in self-interested transactions with the LLC without the requirement of a disinterested vote, and that in any challenge thereto the minority members will bear the burden of proof as to the impropriety of the transaction? May the Majority Members amend the operating agreement to provide mandatory advancement of expenses in the event of any challenge to any transaction they undertake vis-a-vie the company and as well first dollar indemnification for any ultimate liability that does not involve a knowing violation of law? May the Majority Members amend the operating agreement to provide that, in the event of any direct or derivative action challenging an action undertaken by a member of the majority with the company, it shall be referred to a special litigation committee that need not be appointed on a disinterested basis? Alternatively, may it be provided that any direct or derivative challenge to an action undertaken by a member of the company and the LLC shall be subject to mandatory arbitration? Last, but without meaning to suggest that this listing exhaust the possible options, may the majority members amend the operating agreement to provide that they have the capacity to set their own compensation for services rendered to the Company?

        Ultimately, what constitutes a restriction on the duty of loyalty is open to dispute.

       There is a separate and distinct mechanism that needs to be considered. Assume that the LLC is organized in a state that allows a merger to be approved by less than all the members or, in the alternative, that the LLC’s operating agreement grants a similar capacity. Assume as well that neither the controlling act nor the operating agreement provide for dissenter rights in the event of a merger. In that circumstance, without triggering a liquidity opportunity for the minority members, the Majority Members have the capacity to merge an LLC that does not restrain the otherwise applicable duty of loyalty into an LLC in which the duty of loyalty is expressly waived. While the argument should ultimately fail, no doubt the minority members, in an LLC organized in a state that is adopted Dean Freshee’s suggestion would argue that the merger is nothing more than an amendment to the operating agreement.

       Last, I question whether modifications of the duty of loyalty are really that important in typical business organizations. While we read a great deal from Delaware about fiduciary waivers, typically in the instance of fund cases, it is striking how little litigation we see on the point in other jurisdictions. Maybe this is consequent to the fact that those states that have adopted an incarnation of the Uniform LLC Act do not allow a complete waiver of the duty of loyalty, thereby restricting the number of states in which such of provision may appear in the operating agreement. I would submit that rather than being concerned with waivers of the duty of loyalty, minority members in LLCs should focus their efforts at protecting against the elimination of a liquidity right that they might otherwise enjoy, the imposition of a drag-along right or the elimination of a mandatory tax liability distribution. In most circumstances, it is these sorts of modifications in the operating agreement that are more likely to have a true impact upon the minority member’s enjoyment of the benefits of being a member in a particular venture.

      Ultimately, I am of the view that entering into an operating agreement that may be amended without the approval of a particular member constitutes that member placing themselves almost entirely at the mercy of those with the capacity to amend the operating agreement, a point addressed in An Amendment Too Far?: Limits on the Ability of Less Than All Members to Amend the Operating Agreement, 16  Florida State University Business Review 1 (Spring 2017) (with Katharine M. Sagan). Persons entering into those arrangements certainly have the ability to negotiate for any of a number of protections. But when they do not, I do not see it as proper for those members and other participants to be protected from the consequence of the decision they have made.

The Sinking of the White Ship

The Sinking of the White Ship

            Pillars of the Earth is in my view an excellent book both for its description of events “from the ground level” of the period of English history known as the Anarchy as well as its treatment of medieval as people just like those of the modern era who are just trying as best they can to make it through each day.

            The fulcrum of the macro-political events described in the book is The Anarchy, the contest between the Empress Matilda, daughter of King Henry I (and former spouse of the Holy Roman Emperor, hence her title “Empress”), and Stephen of Blois, Henry’s nephew (just to keep things confusing Stephen’s wife was named Matilda) for the English throne after Henry’s death.  The expected heir to Henry I was his son William, the only legitimate male child to have survived to adulthood.  William, however, drowned on this day in 1120 in the sinking of the White Ship, thereby affording Follett the pivot around which to write Pillars of the Earth.

            The Anarchy, wich lasted some 18 years, was resolved by Stephen holding the throne for life and appointing Matilda’s son Henry his heir.  That Henry would be Henry II, one of England’s great kings.

A Local Sighting of the Limited Liability “Corporation”

A Local Sighting of the Limited Liability “Corporation”

      Recently there was filed a complaint alleging that the Louisville “fairness ordinance” infringes upon the rights of the owner of an LLC in the wedding photography and related businesses. This complaint has been reviewed in numerous places, including the Religion Clause Blog; HERE IS A LINK to that posting.

      On page 8 of the complaint, it is asserted that the plaintiff is the sole member of a “limited liability corporation.”

Professor Larry Hamermesh Delivers the 35th Annual F. G. Pileggi Distinguished Lecture

Professor Larry Hamermesh Delivers the 35^th Annual F. G. Pileggi Distinguished Lecture

      Recently, Prof. Larry Hamermesh, of whom I am fortunate enough to count as a friend, delivered the 35th Annual F G. Pileggi Distinguished Lecture in Delaware, wherein he recounted his some 40 years in experience as first a practicing attorney and then a professor at the Widener College of Law in Wilmington Delaware. HERE IS A LINK to a posting from the Delaware Corporate & Commercial Litigation Blog highlighting this presentation.

      Not mentioned in that presentation is that Larry’s service as included as the reporter for the Corporate Laws Committee of the Section of Business Law of the American Bar Association, where he had the pen for the drafting of the Model Business Corporation Act (Third), a project to which he continues to contribute, including in the preparation of the annotated version thereof.

LLCs Are Not Corporations

LLCs Are Not Corporations

      Professor Joshua Fershee, now the Dean of the Creighton Law School, collects cases in which LLCs are incorrectly referred to as a “limited liability corporation.” In a recent posting on the Business Law Prof Blog, he posted Dear Florida: LLCs Are Still Not Corporations. Therein, he reviewed a decision from Florida, it assessing whether or not there existed diversity jurisdiction. That blog posting was made on November 18, 2019; HERE IS A LINK to that posting.

Nevada Supreme Court Holds That Member is Entitled to Books and Records of LLC’s Subsidiary

Nevada Supreme Court Holds That Member is Entitled to Books and Records of LLC’s Subsidiary

      In a recent decision rendered by the Supreme Court of Nevada, it was held that a member was entitled to access to certain business records of a wholly-owned subsidiary of the LLC. Turnberry/South Strip, L.P. v. The Eighth Judicial District Court of the State of Nevada (Centra Park, LLC, Real Party in Interest), No. 77317, 2019 WL 5858938 (Nev. Nov. 7, 2019).

      Turnberry and Centra owned Turnberry/Centra Development, LLC (“TCD”) with Centra being a 30% owner and Turnberry the 70% owner. In addition, Turnberry was the managing member of TCD. In turn, Turnberry/Centra Office Quad, LLC (“Office Quad”), a Delaware LLC, was wholly-owned by TCD. Office Quad in turn had a wholly-owned subsidiary named Turnberry/Centra Office Sub, LLC (“Office Sub”).

       In 2013, Office Sub signed a confidential settlement agreement with Lehman Brothers and others regarding a loan. That settlement agreement resulted in the seizure of certain assets as collateral for those loans. Centra made a written request for copies of that agreement and related documents. TCD, controlled by Turnberry, refused to provide the requested documents. Ultimately the trial court would order the disclosure of the settlement agreement to Centra, whereupon this appeal followed.

      Applying Delaware law, the court began its analysis by noting the rule that LLC Agreements should be construed like other contracts, citing in support Kuroda v. SPJS Holdings, LLC, 971 A.2d 872, 880-81 (Del. Ch. 2009), then turned its attention to the provisions of the operating agreement of TCD addressing the right to access company books and records. In doing so, the court rejected the efforts by Turnberry to restrict Centra to the narrow “books of account,” highlighting as well that the operating agreement afforded the members access not only to the books of account, but also to “all correspondence, papers and other documents.” It also rejected the suggestion that those other documents were available only if they were related only to TCD itself and not any of its subsidiaries, characterizing any contrary result as being “absurd.”

      The court also rejected the suggestion that Centra should not be entitled to review the settlement agreement on the basis that it was not a party to it and it contains as well a confidentiality agreement.

Preferential Distribution Upon Sale of LLC Assets Not Applicable Upon Sale of LLC Membership Interests

Preferential Distribution Upon Sale of LLC Assets Not Applicable Upon Sale of LLC Membership Interests

       In a recent decision from the Superior Court of Pennsylvania, it was held that the sale of the interest in LLC is not equivalent to the sale of the LLC’s assets for purposes of the application of a liquidating distribution preference. Meeco, Inc. v. Clean Growth Fund III, LP, No. 438 EDA 2019, 2019 WL 4887249 (Penn. Sup. Ct. Oct. 3, 2019).

      This dispute arose out of an operating agreement that specifically addressed the liquidating cascade that would apply upon a sale of assets, but which was silent as to other transactions. In this instance, the claim was made that the transaction that was undertaken should be treated as a sale of assets. This the court refused to do as a sale of membership interest is not equivalent to a sale by the LLC of its assets. As to that point, the court wrote:  

We have held that a “membership interest is an ownership interest in a [LLC] and is akin to an interest in stock of a corporation.” The sale of stock is not a sale of a corporation’s assets because “a corporation is an entity irrespective of … the persons who own its stock.” Similarly then, the sale of membership interests in a [LLC], like the sale of stock, is not the sale of assets. Therefore, the trial court properly found that the sale of Membership units was not a “Capital Transaction” within the meaning of Section 9.2 of the Operating Agreement based on its unambiguous language.” 2019 WL 4887249,*4 (citations omitted).

Derivative Action Brought by Limited Partner Dismissed

Derivative Action Brought by Limited Partner Dismissed

      A recent decision from California on a derivative action initiated by a limited partner addresses a pair of important points, namely that suits can be dismissed for lack of standing even on appeal and the ability of the general partner of a limited partnership to decide whether or not litigation will be brought. U. S. Fund and Investment Consultants, Inc. v. MaCauly, C083140, 2019 WL 5611894 (Ca. Ct. App. 3^rd Dist. October 31, 2019).

       Willow Family Housing, LP, organized in Delaware, had as its general partner Central Valley Coalition for Affordable Housing (“CVCAH”). U. S. Fund and Investment Consultants, Inc. (“U.S. Fund”) was one of the limited partners in Willow. Ultimately, a dispute would arise as to the nature of the obligations of Willow to maintain certain rental units for farmworker households under the Serna Program. After US Fund made demand upon CVCAH in connection with challenging actions of the Department of Housing and Community Development with respect to the project, it initiated this derivative action. In dismissing, on appeal, the derivative action, the court found that US Fund lacked standing. 

      CVCAH had informed US Fund that: 

As you are fully aware, Central Valley Coalition for Affordable Housing is the general partner of [Willow]. Management of the Partnership is its right and responsibility…. Without our consent, you, have filed a lawsuit against the State of California and its Department of Housing and Community Development and further have sought a Temporary Restraining Order. We have not even seen the moving papers. The following actions must be taken by you immediately: (1) dismiss the complaint in case number 2013-00152367; (2) take the TRO off calendar; and (3) communicate both actions to counsel for [the Department] and [Chief Executive Officer of CVCAH.]. 2019 WL 5611894, *4.

      After noting that a derivative action may be appropriate where the general partner has a conflict or has engaged in self-dealing with respect to partnership assets, “a limited partner may not sue to vindicate partnership rights whenever the limited partner disagrees with a refusal of the general partner to bring a proposal legal action. Instead, general partners entitled to deference under the business judgment rule.”  

      As there are no allegations of a conflict or self-interested transaction by CVCAH, its determination to not pursue the suit requested by U.S. Fund stands, and US Fund could not effectively override of that determination by bringing a derivative action.

Kentucky Ordered to Issue Vanity License Plate “IM God”

Kentucky Ordered to Issue Vanity License Plate “IM God”

      As reported by Howard Friedman in his blog Religion Clause, earlier this week the Federal District Court for the Eastern District of Kentucky issued a decision directing the state to issue the vanity license plate “IM God.” The Transportation Cabinet had resisted doing so on the basis that it sought to avoid controversy. The court found, however, that it had already issued a number of license plates incorporating “God” and that it could not now refuse to issue this plate. 

      HERE IS A LINK to that blog posting.

When Previously Agreeing Members Disagree

When Previously Agreeing Members Disagree

Peter Mahler, in his blog New York Business Divorce, has this week reviewed a long-running dispute between the co-members of a New York LLC that owns valuable real estate. In a posting titled Operating Agreement Spawns Multiple Disputes Between 50/50 Members of Realty Holding LLC, Peter reviews the numerous decisions and appeals that have arisen in this case. HERE IS A LINK to his review.

There is an element of the most recent decisions that struck me. In this instance, at one time, each of the members agreed that a management company owned by one of the members would be in charge of the day-to-day management of the property. After the falling out, the other member (i.e., the one who did not have an ownership interest in the management company) objected to it continuing to serve in that role. My initial reaction would have been in the nature of “well, having agreed that it would be the management company, and not having imposed any time limits, it remains the management company until such time as a majority of the members decide otherwise.” And I would be wrong.

Rather, those facts, both the trial court and the appellate division held, inter alia, that the continuation of the management company in that role is subject to, in effect, one of the members deciding that should no longer be the case. Specifically:

[T]he continued decision to keep Win Win Asset Management LLC as the managing agent of the company is also a major management decision for the Company, and requires a majority vote. Given that Rubin and Baumann each hold a 50% ownership stake in the Company, the parties are deadlocked as to this fundamental decision regarding its operations.

This capacity to revoke prior agreements as to how an LLC will be operated presents, depending upon your viewpoint, great opportunities for mischief and great opportunities to reset the relationship. That said, written agreements are always recommended. If, for example, there was a written operating agreement with Win Win for a particular term, the lifting of consent would not have any impact until the end of that term and the decision of whether to renew the agreement or enter into a new agreement with a new management company. In this instance, there was apparently no written management agreement between the LLC and that management company.

In this respect, I am reminded of the decision Kirksey v. Grohmann, 754 N.W.2d 825 (S.D. 2008), it involving a four member LLC. The LLC held certain land that was used for livestock grazing and ranching activities. In this instance, the purpose of the LLC, as set forth in its operating agreement, was specific and included “to engage in the general livestock and ranching business.” Id. at 830. That property was leased by the LLC to two of the four members. Two of the members sought to terminate the lease agreements, which termination was opposed by the two members who were the beneficiaries of those arrangements. “Because Grohmann and Randall had no desire to terminate the lease or dissolve the LLC, the parties remained deadlocked.” 754 N.W.2d 827.

Still, focusing upon the intent that all of the four members (the members were all sisters) would share equally in the LLC’s management and operation, the court observed:

Although each sister has an equal vote, there no longer exists equality in the decision-making. Grohmann and Randall have all the power with no reason to change the terms of a lease extremely favorable to them. Leaving two sisters, half of the owners, with all of the power in the operation of the company cannot be a reasonable and practicable operation of the business. Id. at 831.

On that basis a judicial dissolution of the LLC was ordered, in effect allowing the two members to revoke their prior consent to leases of the LLC’s property.

The Latest Geographic Targeting Orders

The Latest Geographic Targeting Orders

For several years now, the Department of Treasury has been issuing Geographic Targeting Orders (“GTOs”) requiring the disclosure to the Treasury of certain real estate transactions. These transactions are restricted to certain cities, and require reports filed with respect to acquisitions of residential properties where there is not a mortgage (i.e., unfinanced cash transactions). The GTOs are intended to combat money laundering.

Last week the Department of treasury issued the latest GTOs. They require reporting of transactions of $300,000 or more in a number of markets including New York, Miami, Las Vegas and Honolulu.

HERE IS A LINK to the latest GTO. HERE IS A LINK to a related FAQ.

Missouri Court of Appeals Addresses “For Himself” as to Reorganization and Disassociation

Missouri Court of Appeals Addresses “For Himself” as to Reorganization and Disassociation

In a January, 2019 decision of the Missouri Court of Appeals, Nicolazzi v. Bone, No. ED 106292, 2018 WL 6052144, 564 S.W.3d 364 (Mo. Ct. App. Div. 4 Nov. 20, 2018), it sent back to the trial court the question of Nicolazzi had withdrawn from the LLC by the act of filing a lawsuit addressing in part the LLC’s composition.  As do many LLC Acts, that of Missouri, at § 347.123(4)(c), identifies the events of withdrawal as including:

Unless otherwise provided in the operating agreement whereby specific consent of all members at the time, the member … files a petition or answer seeking for himself any reorganization, arrangement, composition, readjustment, liquidation or similar relief under any statute, law or regulation.

The Court of Appeals wrote that, notwithstanding the question needs to be resolved by the trial court:

We remand this case with instructions for the trial court to determine whether [Nicolazzi’s] filing of his petition constitutes an “event of withdrawal” pursuant to § 347.123(4)(c).

HERE IS A LINK to my review of that earlier decision.

In this follow on decision, Nicolazzi v. Bone, ___ S.W.3d ___, 2019 WL 5700365, *4 (Mo. Ct. App. Eastern Dist. November 5, 2019), it was held that the provision addresses the member, and not the LLC, a determination that is consistent with the decisions of a number of other jurisdictions.  The court wrote:

Our exhaustive multi-jurisdictional review demonstrates that courts interpreting statutes with nearly identical language have rejected the argument that a person’s membership automatically is relinquished when the individual member seeks reorganization or dissolution of the LLC rather than for itself.

Illinois LLC Act Amended as to Member’s Right to Inspect Books and Records

Illinois LLC Act Amended as to Member’s Right to Inspect Books and Records

In 2019 Illinois amended its LLC Act to provide that a (a) a member denied access to requested books and records may bring an action to enforce that right, (b) permits an award of attorney fees and costs incurred in favor of the member against the company where the LLC did not comply with the statute and (c) allows a court to impose restrictions on the access to and use of the information “based on the reasonable needs of the company and the member in question.”  See 805 ILCS 180/10-15 as amended by 2019 Illinois Senate Bill No. 1495 (adding new subsection (j)), which provides:

If the company fails to provide any information  required to be provided by this Section, the person entitled to  the information may file an action to compel the company to  provide the information and to obtain such other legal or  equitable relief as may be proper. If the court finds that the  company failed to comply with the requirements of this Section,  the court may award the plaintiff its reasonable costs and  attorney's fees incurred in bringing and prosecuting the  action. The court may, in connection with any information  described in subsection (h), impose such restrictions and  conditions on access to and use of such information as it deems  appropriate based on the reasonable needs of the company and  the member in question. 

New York and Identifying LLC’s Members on Transfer Tax Returns; Not for Condo Purchases

New York and Identifying LLC’s Members on Transfer Tax Returns; Not for Condo Purchases

     Legislation passed in 2019 in New York requires the listing of the members in the real property transfer tax return filed in connection with the purchase or sale of residential real estate of up to four units. See A.7190/S.1730; see also John Whitaker, LLCs Purchasing Real Estate Will Now Share More Information, The Post-Journal  (August 9, 2019); HERE IS A LINK to that story.

            In a story published in the Wall Street Journal on November 7, Condo Buyers Can Keep Purchases Secret, N.Y. Tax Officials Say in Reversal it was stated that in response to objections to needing to report the beneficial ownership of LLCs purchasing condominiums in New York, the law will be applied only to “buildings,” which will exclude condo units. 

            HERE IS A LINK to that story from the Wall Street Journal, and HERE IS A LINK to the equivalent article from the Gothamist.

More on the Interstate Transport of Krispy Kreme Doughnuts

More on the Interstate Transport of Krispy Kreme Doughnuts

Previously I reviewed an AP Wire story about Krispy Kreme’s objection to a student who was driving from Minnesota to Iowa each weekend to buy a hundred boxes of doughnuts and reselling them back home. Krispy Kreme contacted him and said he could no longer do so. HERE IS A LINK to that posting.

Well, according to a follow on story (HERE IS A LINK), Krispy Kreme has reversed course and is even donating doughnuts to the entrepreneurial student. They assert that they did not realize he was trying to earn money in order to graduate college debt free. Okay, fine, but what happened to the initial objection based upon liability?

Day 2 of the 2019 LLC Institute

Day 2 of the 2019 LLC Institute

       The second day of the 2019 began with a presentation by Professors Lee-ford Tritt and Peter Molk on Business Trusts and comparing them to LLCs.  The discussion included the taxation of business trusts and the seeming impediments to their broader use.  

      The morning continued with a program chaired by Cristin Keane. Joined by Professor Gregg Polska and Warren Kean, they addressed taxation of service providers in pass-through entities.  Sections 199A and 409A along with insights on ordinary and capital gains income, tax partners as employees (not) and phantom versus real interests were all reviewed. 

       The morning was brought to a close with the ethics program presented by Bob Keatinge, A.J. Singleton and Gerald Niesar.  They focused upon issues particular to the organization of a law firm, including the “non-equity partner,” and the challenges involved in merging firms.  Having independent legal counsel be charged with identifying and possibly resolving conflicts was identified as an option to be considered.

       Over our lunch Garth Jacobson gave a quick report as to the status of beneficial ownership reporting, both as to where matters stand in Congress and the status of the ABA’s efforts to participate (or not) in the debate.

       After our lunch meeting we held the Lightning Round.  Featuring Professor Christine Hurt, Scott Ludwig, Suzanne Odom, Stuart Pachman and Tom Rutledge, the Lightning Round was a new format for the LLC Institute where each presenter gave a quick (10 minute) review of a discrete topic.  Professor Hurt started us off with a presentation on unintended partnerships; she has a forthcoming article on the topic that is in the materials (and which is highly recommended to you).  Scott Ludwig reviewed a recent situation on the use of remedial allocations where his client was a non-profit.  As proposed his client would have suffered UBIT with no opportunity to recover upon liquidity.  Suzanne Odom reviewed the LLC acts of various Indian tribes and material distinctions between them and as to the uniform and other acts with which we are familiar.  Stuart Pachman, who did a piece in Business Law Today on the topic, addressed succession in what was or became a single-member LLC so as to avoid dissolution for lacking a member.  Tom Rutledge addressed proposed changes to the FRCP that will if enacted make the determination of the citizenship of an unincorporated entity easier to accomplish.

      The last panel on Friday was chaired by Tarik Haskins and included Marla Norton and Professor Beth Miller.  They addressed developments in Delaware law (including as contrasted with the laws of other jurisdictions) as to series, to divisions and electronic signatures.

        Thanks to Mark Page from the ABA for being on-site with us.

       The materials and power points are posted (although as I write this we are still making sure it is only final versions) on the meeting materials link to the registration page for the LLC Institute.  In maybe two weeks the audio recordings of the programs will be posted. That said, while you can no doubt learn a great deal from those materials, the greatest value of the LLC Institute comes from attending.  If you were not with us in 2019, hopefully you will be in 2020.

LLC Act Specifically Provides Immunity from Personal Liability for an LLC’s Breach of Contract

LLC Act Specifically Provides Immunity from Personal Liability for an LLC’s Breach of Contract

In a recent decision from the Kentucky Court of Appeals, it reaffirmed the rule that the members of an LLC are not liable for its debts and obligations. In this instance, even where the member of an LLC allegedly caused it to breach an agreement to which it was a party, no personal liability attached. Pulaski Properties, Inc. v. Haney, No. 2018-CA-000341-MR, 2019 WL 5092461 (Ky. App. Oct. 11, 20).

In this case, Pulaski Properties, Inc. (“PPI”) alleged that Acton, the managing member of Lake Cumberland Investments, LLC (“LCI”) should be held personally liable for the breach of a contract between LCI and PPI. As recited in the decision of the Court of Appeals, it was alleged that “Acton effectively and legally is LCI for all purposes pertaining to the agreement with [PPI.]” (bracketed language in original) and that “[b]y failing to cause LCI to honor the agreement by the simple expedient of making the conveyance in his capacity as manager, yet personally accepting and keeping part of the consideration thereof, he should indeed be liable for breach of contract.” 2019 WL 5092461,*3. In response, the court relied upon KRS § 275.150, it affording the members, managers and other constituents and representatives of an LLC limited liability from its debts and obligations, the court ultimately holding “Thus, KRS 275.150 specifically provides immunity from personal liability for members/managers of an LLC in instances such as this.” Id., *4.

In addition, the court found that there could be no breach of contract for which Acton could be liable because the alleged agreement did not satisfy the requirements of the Statute of Frauds.

Day 1 of the 2019 LLC Institute

Day 1 of the 2019 LLC Institute

       Day 1 of the 2019 LLC Institute started with the usual announcements and a thank you to Holland & Knight / Lou Conti for the reception they presented for us last evening.  It was a great start to the LLC Institute.

       The substance of the Institute began Thursday morning with the always popular case law review chaired by Professor Beth Miller. Joined as she has been in recent years by Dan Sheridan, Kelley Bender and Sean Ducharme, they collectively reviewed a variety of cases from across the country.  

      Sean, in his review of a variety of piercing the veil cases, noted that an open question is whether the burden of proof should be preponderance or clear and convincing. Dan reviewed cases addressing rights of indemnification and the admission of new members.  Kelley reviewed a number of dissolution decisions, noting how courts sometimes struggle with the application of statutes governing dissolution and the gaps therein.  Other of the decisions she reviewed addressed standards for judicial dissolution and specifically the LLC’s purpose.  Beth began by reviewing a Connecticut decision wherein the state Supreme Court recognized that while the legislature barred reverse piercing, it still existed for claims pre-existing the effective date of that statute.

       Kelley Bender put in a most justified plug for Peter Mahler’s blog New York Business Divorce.

        The next panel, it focusing upon Delaware and bankruptcy case law developments, featured Lou Hering, Tammy Mercer and Jim Wheaton.  Jim began with the bankruptcy decisions, including the lack of standing  of a bankrupt sole member when the trustee sold the LLC’s assets, operating agreements as executory agreements, and bankruptcy remoteness. Tammy’s presentation began with a limited partnership / Caremark case. She reviewed the concept of “contractual fiduciary duties” and with comments from the audience addressed related standing and remedies implications.  Tammy and Lou continued with the review of several other Delaware decisions addressing points including whether a member subject to a non-compete may compete thru a wholly-owned affiliate (short answer = “no”) and the implications of a “void” act.

       We then adjourned to our lunch whereat Dean Don Weidner presented a high energy keynote address on the developments in liquidity rights in unincorporated entities and the shift from withdrawal = liquidity to a rule of capital lock-in and restricting participants to derivative rather than direct actions for breach of the controlling agreement.  

      After lunch we convened for a panel led by Professor Brad Borden, he joined by Michael Soejoto, addressing Contribution Default Remedies in Operating Agreements.  They reviewed whether interest dilution is effective in a failing venture to compel performance (often it is not) and what might be on relevant facts effective remedies.  The presentation was highly technical, but the topic is highly technical; you need to do the math. 

       The afternoon’s presentations ended with a program chaired by Peter Mahler was titled LLC Agreements That Went Wrong and How to Fix Them: Case Studies and War Stories.  Joined by Ladd Hirsch, Professor Meredith Miller and Lou Conti, they addressed a variety of situations and cases in which the operating agreement was from one perspective just fine and from the other perspective horribly unfair.  The purpose clause and dissolution was highlighted by Peter, while Ladd focused upon transfer of an interest provisions.  Professor Miller addressed dispute resolution provisions in operating agreements.  Lou Conti batted clean-up by focusing upon management and fiduciary duties.

      

      Thursday evening continued with a cocktail hour and then the Lubaroff Award Dinner.  Before turning to that award the Committee’s Content Award, sometimes known as the Beth Miller Award That We Cannot Name After Beth As She Is Still With Us, was presented to Gerald Niesar in recognition of his many years of contributions to partnership and LLC Law, including as the primary drafter of the White Paper that initiated what became RUPA.  Beth Miller made the presentation to a surprised Gerry.

       The dinner then turned to the Lubaroff Award and honoring Professor Dan Kleinberger.  With Lauris Rall serving as master of ceremonies, the comments began with those of Carter Bishop, Dan’s long-time co-author and co-conspirator in all things involving LLCs and their work as reporters (jointly and individually) got various uniform law projects.  Without intending to name everyone, Jim Wheaton, Scott Ludwig, Beth Miller, Steve Frost and Lisa Jacobs all spoke.  Lou Hering, in addition to lauding Dan, gave our traditional remembrance of and toast to the memory of those no longer with us.  After the comments Dan took the stage.  After explaining why he was not wearing his trademark black shirt (even though many of us in attendance had dressed in black), Dan addressed his wonderful family, his work with Carter and his work with our Committee. And he spoke of his remembrances of Marty Lubaroff. Our proceedings concluded with the presentation of the award by Christina Houston.

       So ended the first day of the 2019 LLC Institute.

Charging Orders Affirmed

Charging Orders Affirmed

In this third appeal of a family dispute, the Washington Court of Appeals affirmed the issuance of a charging order in support of certain judgments graned to one sibling against another. Bangasser. v. Bangasser, 2019 WL 5112459 (Wash. Ct. App. Oct. 14, 2019).

As the court noted, this is the third appeal in this case. Thomas Bangasser served as the general partner of Midtown Limited Partnership, a partnership that held certain commercial real estate in Seattle. The limited partners in that partnership were Thomas’ siblings or entities owned by those siblings. Various of the siblings had made personal loans to Thomas, which loans were never repaid. Ultimately, the limited partners removed Thomas as the general partner, and he brought suit alleging that his removal was in violation of the partnership agreement. Roughly coincident in time, the siblings who had loaned money to Thomas, brought suit to enforce the promissory notes and to collect thereon.

Ultimately, Midtown would sell its real estate for a total of some $23,300,000. In support of the judgments enforcing the promissory notes, the court issued charging orders against Thomas’ distributions. The limited partnership deposited approximately one half of his anticipated proceeds from the sale in court against a potential claim of a purported transferee of a portion of Thomas’ interest in the limited partnership.

The decision affirmed the validity of the charging orders, including that they could be used to collect attorney’s fees pursuant to the promissory notes Thomas had executed.

Shareholders and Officers of Business Corporation Personally Liable for Violation of PACA

Shareholders and Officers of Business Corporation Personally Liable for Violation of PACA

In a recent decision from Georgia, the court held that certain officers and shareholders of a corporation could be held personally liable for violations of the Perishable Agricultural Commodities Act of 1930 (“PACA”). Baker & Murakami Produce Company LLLP v. Weng Farms Inc., Case No. CV 418-0252, 2019 WL 5491895 (S.D. Ga. Oct. 24, 2019).

The plaintiffs alleged that they had sold produce to the defendant Weng Farms, Inc., but had not been paid. The amounts due and owing were $302,078.25. The plaintiffs sought to hold Lea Weng and William Foster, owners and officers of Weng Farms, personally liable on those claims. Normally, that would not be possible because the shareholders and officers of business corporations are not personally liable for its debts and obligations. In this instance, all else was not equal. Rather, the product that had been sold was agricultural produce and, under PACA, assuming certain notices requirements are satisfied (they were in this case), there is imposed upon the purchaser of produce a statutory trust for the proceeds from which the seller would be paid.

Weng Farms never answered the complaint. In this decision awarding a default judgment against the individual defendants (default was not sought against Weng Farms itself), that default judgment was justified on the basis that:

Individual defendants are subject to personal liability under the PACA when they “are in a position to control PACA trust assets,” such as officers, directors, and shareholders “and fail to maintain the assets.” 2019 WL 5491895, *4 (citations omitted).

The court went on to find that the claim for attorney’s fees incurred in connection with the action were due and owing and were likewise subject to the PACA trust.

The Kentucky Uniform Voidable Transactions Act

The Kentucky Uniform Voidable Transactions Act

In recent decision from the Kentucky Court of Appeals, it discussed the application of Kentucky’s former law with respect to fraudulent conveyances and the adoption, effective January 1, 2016, of the Uniform Voidable Transactions Act, which has now been codified at KRS ch. 378A. Orchard v. Western Energy Production, LP, No. 2019-CA-000066-MR, 2019 WL 5293489 (Ky. App. Oct. 18, 2019).

With respect to the application of fraudulent conveyance law, the transfers at issue took place on August 25, 2015. Obviously that date predates the effective date of the Kentucky Uniform Voidable Transactions Act.. Relying in part upon in re Licking River Mining, LLC v. Monday Coal, LLC, 571 B.R. 241, 245 N.3 (Bankr. E.D. Ky. 2017), it was held that the former fraudulent conveyance law, and specifically KRS § 378.010, would apply to the allegedly improper transactions.

Attorney Not Legitimately Hired By LLC = No Attorney-Client Privilege

Attorney Not Legitimately Hired By LLC = No Attorney-Client Privilege

In a recent decision from Tennessee, the court was called upon to determine whether an attorney had been properly hired on behalf of an LLC.  The court held that he had not.  Inconsequence there was not attorney-client relationship and no attorney-client privilege.  Morristown Heart Consultants, PLLC v. Patel, No. E2018- 01590-COA-R9-CV, 2019 WL 3318184 (Tenn. Ct. App. July 24, 2019).

This case involved a dispute between two unequal members in a two member LLC.  While each member had a right to 50% of the earnings of the LLC, Dr. Ramaprasad held a 67% management right while Dr. Patel held a 33% interest in management. The court held that the majority member’s “act of hiring an attorney to represent [the LLC] in a potential action against [the second member] was not in the ordinary course of the LLC’s business.”  The operating agreement, as to actions not in the ordinary course, required member approval. But Ramaprasad never got that consent. He never called a meeting of the members to consider the matter. And he never signed a written consent that would have authorized him to act outside of a meeting.

Alternatively, MHC could have accomplished the act by written consent without having a meeting. Without a meeting, Mr. Ramaprasad could have signed a written consent with his majority governing rights to approve the hiring of Mr. Bowlin and provided notice to Dr. Ramaprasad of the LLC’s action. No evidence is in the record on appeal of written consent approving the action signed by Dr. Ramaprasad or notice of such action provided to Dr. Patel. (citation omitted). 2019 WL 3318184, *5.

As the majority member had not employed the procedure mandated by the company’s operating agreement, the attorney was never properly hired on behalf of the company which had the effect of waiving the attorney-client privilege. Patel is permitted to access the attorney’s file.

Interstate Transport of Krispy Kreme Doughnuts Prohibited

Interstate Transport of Krispy Kreme Doughnuts Prohibited

According to a recent story on the AP Wire, a college student in Minnesota was on a weekly basis driving back-and-forth to Iowa to buy Krispy Kreme doughnuts. There are, apparently, no Krispy Kreme stores in Minnesota. Upon arrival, said student was reselling the doughnuts. According to that same AP Wire story, Krispy Kreme has reached out to the student and told him he was prohibited from continuing with his interstate transport of doughnuts because of potential liability to Krispy Kreme.

The newswire story did not provide any detail as to what exposure the shop could have, and I am befuddled in an effort to come up with one. If the donuts were safe for consumption when they left the store, they are no less safe for consumption having crossed the state border.

HERE IS A LINK to that story.

The Member of the LLC Does Not Own the LLC’s Property

The Member of the LLC Does Not Own the LLC’s Property

In a recent decision from the Bankruptcy Court in Wisconsin, there was applied the rule that an LLC is a legal entity distinct from its members to the effect that the members have no ownership interest in the LLC’s property. As applied in this case, the bankruptcy estate of the sole member of an LLC did not include the property owned by that LLC. In Re Gialamas, ___ B.R. ___, 2019 WL 4201548 (W.D. Wisc. Sept. 4, 2019).

Erick Hallick held a judgment against Thomas Gialamas for almost $17,000,000. Gialamas was, in turn, the sole owner of Blackhawk Junction, LLC, a limited liability company that owned a strip mall. When Gialamas filed for personal bankruptcy protection, Hallick sought an order of abandonment of the property owned by Blackhawk Junction. Both Gialamas and the Creditors Committee objected, arguing that Hallick did not have a lien or other protectable property rights in that property.

After disposing of the argument that a supplemental proceeding in support of collection of the judgment does not create a lien in the judgment debtor's personal property, the court went on to find that there was no protectable interest in the strip mall. Rather:

[T]his court must conclude for purposes of this motion that the movant has not met his burden of demonstrating that the real estate is now property of Mr. Gialamas’ bankruptcy estate. The parties stipulate that at all relevant times the Debtor has owned a membership interest in Blackhawk Junction, LLC. But that simply means his membership interest in Blackhawk Junction, LLC was property of the bankruptcy estate. The underlying assets owned by the LLC are not. 2019 WL 4201548, *3.

In support of this language, one authority cited by the court was In Re Conan, 487 B.R. 539, 541 (Bankr. W.D. Wisc. 2012) which is cited for the proposition that “although the estate includes the membership and ownership of the LLC, it does not include the assets owned by the LLC. Those assets do not become property of the debtor’s bankruptcy estate.”

As the bankruptcy estate did not own the strip mall property, there existed no basis by which it could be ordered to abandon it.

Not addressed by this opinion was a charging order that Hallick had received against Gialamas, which charging order was supported by the appointment of a receiver.

In a footnote, the court noted that there existed an unresolved question as to whether the charging order provisions of the Wisconsin Limited Liability Company Act are the exclusive remedy for a claim against a member’s interest in an LLC. That determination will obviously await another dispute.